A second mortgage is a mortgage loan secured by real estate that already has a mortgage on it. It is called a “second” mortgage because it is in line to be paid in case of foreclosure. In foreclosure proceedings, liens on the property (like mortgages) are paid off in order of seniority. The first mortgage on the property will be paid first, and the second mortgage will be paid after the first mortgage is paid.
Where first mortgages use the property as collateral for the loan, second mortgages often involve borrowing against the equity in your home. Equity is calculated by the loan to value ratio. The loan to value ratio is the difference between the market value of your home and what is currently owed on the home.
Why Do People Take Out Second Mortgages?
Individuals have various motivations for taking out second mortgages on their homes. In some circumstances, individuals use the funds from the second mortgage to pay off credit card debt or other kinds of debts. This permits them to save cash, as the second mortgage may often have a lower interest rate than credit card rates.
Other motivations to take out a second mortgage include financing home modifications, such as renovations, and obtaining additional business loans. Some individuals also have a second mortgage as part of their home buying process to bypass private mortgage insurance (sometimes called PMI). Depending on the lender’s requirements, a second mortgage may be used to “piggyback” on the first mortgage to make a sufficient down payment on the home that does not require PMI.
While interest from second mortgages used to be tax-deductible in many circumstances, current changes to tax laws require you to use the money for “substantial improvements” to a home. This allows you to qualify for tax deductions based on the second mortgage’s interest.
What Do You Need To Get A Second Mortgage?
Before we speak more in-depth about what second mortgages are and who they’re for, let’s discover a little bit more about home equity. Your home equity determines how much cash you can get when you take out a second mortgage.
Unless your mortgage loan has a balance of $0, a lien stays on your home. Your mortgage lender has the liberty to take it back if you default before you finish paying back the loan. As you pay off your principal loan balance over time, the part of the loan you have paid off is equity.
Calculating your home equity is fairly straightforward. Subtract the amount you’ve paid toward the principal balance of your home from the total amount you borrowed.
For instance, if you purchased a home worth $300,000 and paid off $70,000, including your down payment, you have $70,000 worth of equity in your home. The interest you pay on your mortgage doesn’t count toward your home equity.
Your home equity can also grow in other ways. If you’re in a growing real estate location or you make improvements on your house, the market value of your house goes up. This change improves your equity without extra payments. On the other hand, if the value of your home goes down and you enter a buyer’s market, you may lose equity.
Second Mortgage Vs. Refinance: What’s The Distinction?
A second mortgage is separate from a mortgage refinance. When you take out a second mortgage, you add a completely new mortgage payment to your list of monthly responsibilities.
You must pay your original mortgage and another payment to the second lender. On the other hand, you pay off your original loan and replace it with your original lender’s new set of loan terms when you refinance. You only make one payment a month with a refinance.
When your lender refinances a mortgage, they understand there’s already a lien on the property, which they can take as collateral if you don’t pay your loan. Lenders who take a second mortgage don’t have the same security.
In the occurrence of a foreclosure, your second lender only gets compensated after the first lender gets their money back. This means that if you fall far behind on your original loan payments, the second lender might not get anything at all. You may have to pay a higher interest rate on a second mortgage than the refinance because the second mortgage lender accepts the inflated risk.
This leads many homeowners to select a cash-out to refinance a second mortgage. Cash-out refinances provide a single lump totality of equity from a lender in exchange for a new, more heightened principal. Mortgage rates of cash-out refinances are almost invariably lower than second mortgage rates.
What Kinds of Second Mortgages Are There?
Generally, the mortgage offerings are the same for second mortgages as they are for first mortgages. You can find an assortment of loan offerings by speaking to a skilled mortgage broker or mortgage lender. Second mortgages may be fixed-rate or adjustable-rate, depending on various factors, including your debt to income ratio, the amount of equity you have built up in your house, and your mortgage needs.
Remember that the interest rates for second mortgages tend to be higher than those for first mortgages and that the amount borrowed will usually be lower than the first mortgage.
What About HELOCs?
Home Equity Lines of Credit (also called HELOCs) are occasionally referred to as second mortgages, although slightly distinguishable. Both types of loans use your home’s equity as collateral, and both will show up on your credit report and in a title search performed by a real estate attorney. However, a HELOC works like a revolving line of credit instead of a one-time static withdrawal.
While a second mortgage has a fixed loan amount with a fixed repayment term throughout the life of the loan, a HELOC works a tiny bit differently. A HELOC permits you to draw out money up to a maximum amount. You don’t owe the lender anything until you make the withdrawal on the credit line, which means monthly payments hinge on whether you have an outstanding balance on the credit line — in some ways similar to a credit card.
What Kind of Credit Do I Need For a Second Mortgage?
Like with first mortgages, there are many loan programs to fit your needs. Depending on your credit history and the amount of equity you have in your house, you may be able to borrow more against the equity in your home. The more equity you have and the sounder your credit score, the better your chances of discovering a loan program that is suitable for you.
Should I Talk to a Lawyer?
If you are considering a second mortgage on your home, it is a good idea to speak with a qualified mortgage attorney. The right attorney can help you by explaining different financing options depending on your needs and what you can expect from taking out a second mortgage.
Your attorney can also perform a title search on the property as the lender requires, review your loan documents with you, and advise you regarding your obligations under the loan and the best way to move forward.